ESG stands for Environmental Social Governance. Although it may feel like a new trend, ESG investing goes all the way back as the 1500s! It was first adopted by religious groups like Quakers who wanted to invest and grow their money, but couldn’t go against their religion. By excluding certain things, such as alcohol or contraband, they could still enjoy the benefits of investing, without compromising their principles. Even today, managers still exclude alcohol, pornography, weaponry and gambling from ESG funds.
ESG has a very broad meaning
The term 'ESG' itself was first coined in the 1970s, in a document called 'Frankfurt-Hohenheimer Guidelines'. This hefty document listed 850 different criteria for ethical investing. To make it more manageable, the authors grouped these initiatives into three distinct groups - Environmental, Social or Governance.
BEWARE: ESG means investments can be good for the environment OR society OR governance. It doesn’t have to be all three.
Examples of environmental investments
Investments which focus on the environment include things like:
- Preventing pollution
- Sustainable waste management
- Green energy
- Cutting carbon emissions
An example of an environmental investment could be a solar or wind energy plant. By investing in green energy, we reduce our reliance on carbon-intensive fossil fuels. Another example could be a company that has stopped all single-use plastic, replacing it instead with sustainable alternatives.
Examples of social investments
Social investments cover businesses and opportunities which help society, for example:
- Offering accessible healthcare
- Providing education
- Boosting gender equality
- Supporting mental health
- Promoting LGBTQIA+ values
- Supporting immigrants, refugees and minorities
An example of a social investment is affordable housing. When investors put their money towards building safe and affordable housing, they help to conquer homelessness or isolation. Another example could be to invest in micro-loans to help small business launch, which boosts entire communities.
Examples of governance investments
Some people refer to this category as 'corporate governance' because it usually related to companies. This category of investments aims to promote the best corporate practices. But often, it can seem more like rewarding companies for simply following the law. Some examples of good corporate governance include:
- Having a diverse group of people on the board
- Promoting career progression and gender equality within the company
- Steering clear of corruption
- Not bribing politicians or working with the mafia
- Paying taxes fairly
- Paying employees fairly
Some examples of governance investments could include companies which have at least 30% women on their board. Or companies who pay their employees fairly, ensuring that all out-sourced workers have safe living conditions too.
How is ESG calculated?
At the time of writing, there is no universal way of measuring ESG. Generally, a fund manager will score a company on how good their environmental, social or governance efforts are. Then they will provide an overall score.
Figuring out the score is hugely time-consuming and it takes a lot of money. Plus, it’s never constant, as the company moves forward and their priorities and products change.
Often the companies simply provide their own data which managers assess. As you might imagine, this is like letting companies 'grade their own homework', and it can lead to some dubious results.
To try to get a handle on the situation, many groups have come forward with initiatives for a universal measurement system. But there is still a long way to go!
ESG investing does not mean charity
In the past many investors mistakenly thought that companies doing good for the world cannot be profitable. They even created the phrase that ethical firms can 'do good, but not well'.
But, as we know today, this is not true. Many companies that are sustainable for the planet are also profitable. Often more so than dirty or unsustainable companies!
Think of renewable energy plants, vegan products or second-hand marketplaces. These are just some examples of sectors which do good AND do well.
ESG investing is not the same as CSR
An ESG company must have either an environmental, social or governance element as an intrinsic part of the business model. Sadly, many companies will consider themselves to be ESG because of charitable initiatives on the side. This is called 'Corporate Social Responsibility' or CSR and it’s not the same thing.
For example, if a bank poured billions of dollars into fossil fuel, sponsoring a local charity wouldn’t make it sustainable. Or if a fast food company deforested hundreds of thousands of hectares of the Amazon rainforest, introducing an internship scheme wouldn’t make it ESG. These are all real examples and these companies are actually listed on ESG funds. When companies think that a little bit of green is enough to undo all the damage they’re doing, it’s usually considered to be greenwashing.
This shows how important it is to check holdings closely. Be your own wealth manager! If you don’t agree with the companies you’re investing in, there are many more funds and managers out there. Make sure you pick a fund you feel happy and comfortable with. After all, it’s your money and your future!
ESG and greenwashing
The biggest problem with ESG investing today is that many unsustainable companies are jumping on the bandwagon and labelling themselves ESG… even though it’s often untrue! This is known as greenwashing and it’s becoming quite prevalent.
The ONS has calculated that globally we need to invest $6.3 trillion in the planet, every year from now until 2030. (For context, the entire annual GDP of the UK in 2020 was $2.7 trillion). If we can meet this target, we will be able reach our climate goals and prevent a global catastrophe.
But ESG investing already brings in more than $40 trillion. And the planet has never been in a worse condition. This shows how serious the problem is. It’s estimated that one in three investments has called itself 'ESG' now. And, as well-meaning investors continue to pour money into the space, companies continue to pollute. You only need to look at the weather outside to see that something isn’t working.
On the ESG fund lists, you can find banks who pour billions into fossil fuels, junk food companies, fizzy drinks manufacturers, global coffee shop chains, fast fashion, oil companies and more … Always check before you invest!
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Please bear in mind that, as with all investing, your capital is at risk. The value of your investments can go down as well as up.
The information contained in this article is for general guidance only and is not intended to constitute investment advice or any other advice or recommendation.